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- U.S growth to outperform expectations in 2019
- Fed will still continue hiking rates
- U.S. Dollar tipped to strengthen this year
The U.S. Dollar will probably strengthen against most major counterparts in 2019 on the back of U.S. economic outperformance and the resultant interest rate rises at the U.S. Federal Reserve says Stephen Stanley, Chief Economist at Amherst Pierpont.
"My read would be that the Dollar will probably be a little stronger (in 2019), in the sense that the U.S. economy will be doing better than others and that Fed - to the extent that it tightens - will be the only game in town as far as that goes, as I don’t think any of the other major central banks will be doing anything like that themselves,” says Stanley.
Higher interest rates tend to push up the value of the Dollar because they attract and keep more foreign capital from investors drawn to the promise of higher returns.
Consensus expectations for U.S. growth have fallen at the start of 2019 amidst fears the economy is peaking, but Amherst Pierpont are more optimistic, expecting growth of 2.X% and “nearer to 3% than 2%”.
Up until now, growth has been obscured by a slow Q1 due to shut-down and bad weather, and because the data has been delayed. But once the government shutdown ends and the “"bank of fog" that has been clouding the picture disperses, the data will continue to show strong growth momentum in the economy.
"I don’t think this rate hike cycle is over, I think the economy still has a lot of momentum and the Fed is going to have to continue raising interest rates to keep it under control," says Stanley.
The economist likens the situation to that of the cycle in 2004-6 when the Fed hiked interest rates 17 times to a high of 5.0%, and although he does not expect interest rates to rise as high as that in this cycle, the pattern will probably be similar.
“In many ways, this is like the last cycle in 2004-6 when the Fed tightened 17 times in a row and once we got to number 4, number 5, the market started to talk about it being almost over, this was going to be the last one, the next was going to be the last one; and we did this over and over again, until we eventually got to 5% rates - I don’t think we are going to get to 5%, but I think the economy still has a lot of momentum," says Stanley.
Part of the reason consensus do not believe the Fed will raise interest rates is because it is simultaneously carrying out quantitative tightening, a process by which the Fed stops reinvesting the principal it earns from the maturing bonds it bought during its programme of quantitative easing (QE).
This also has a tightening effect on the economy much like raising interest rates, but the market is over exaggerating the impact of Quantitative Tightening says Stanley.
"I just don’t think that going from $1.8tr to $1.5tr in excess reserves is the main reason why stocks went down in November and December," says Stanley in an interview with Bloomberg News. "I think the Fed is effectively humouring the markets, saying ‘ok we hear you, we are listening we will revisit if necessary’ but I think the Fed will just go on doing what they have been doing which is, as it says, ‘watching the paint dry’ as the balance sheet runs down."
The Dollar could also gain some support from an improving trade deficit. The deficit widened at the end of 2018 because many nations front-loaded exports to the U.S. in order to get them in before the tariffs kicked in. This had the effect of increasing the depth of the U.S.’s trade deficit, which is often a negative factor for the currency. Stanley, however, sees this effect easing in 2019 and that it could even result in a small trade surplus, although much depends on the outcome of trade talks with China.
One negative spot for the U.S. economy is in the area of business investment where companies have been “sitting on their hands” says Stanley. Market volatility, the government shutdown, and trade talks are the major factors preventing greater investment.
Recent data also showed a deep decline in the housing market which is often seen as a canary in the coal mine of the wider economy. U.S. pending home sales fell -9.8%, in December, the largest decline for over 6 years.
Sales in Southern California fell over -20% in the same period, the slowest rate since 2007, and triggered even deeper concerns about the state of the housing market in the U.S. and the broader economy.
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